Regional banks are not immune from the strains of the financial meltdown and could be the next group of companies to feel the effects of it, warns Bill Gross, chief investment officer at Pimco.
Investors and regulators do not believe that regional banks such as Keycorp, Regions and BB&T are too big to fail, the bond fund guru told CNBC.
In fact, he said, regional banks could be in worse shape. They lack diversity in their funds, Gross said. Regional banks also have trouble, the same as larger banks, in getting access to capital in a tight credit market.
U.S. Treasury Secretary Henry Paulson’s recently commented that some banks are just too large to fail. Yet Paulson did not define where that line falls.
“How big is too big?” Gross asked.
Gross expects the Federal Reserve will hold its key interest rate at 2 percent for the remainder of the year as the economy continues to deal with so many daunting challenges.
He also said that he expects the Fed to take a cautious approach to monetary policy while bank write-offs continue and inflation bubbles up.
“There’s a lot of stress in the financial markets. Let’s face it, this economy, the U.S. economy, and even the global economy, is delevering, and when an economy delevers, there are substantial problems and substantial risks.”
Gross said inflation will ease over the next year, and that will present a challenge to the Fed.
“Inflation, as measured by the core which is what the Fed follows, is basically going to come down over the next 12 months, and that means that the Fed funds level at 2 percent is certainly neutral and may not even be stimulative … in terms of our significant asset deflation,” Gross warned.
Gross isn’t alone in his dismal assessment of the U.S. economy. Several Wall Street analysts are also slashing their earnings estimates on Standard & Poor’s 500 companies.
Merrill Lynch analyst Edward Najarian warned that large cap regional banks will be facing difficulties preserving capital and paying out dividends. Banks stocks will be in “capitulation mode.”
Najarian warned investors that these bank stocks will “likely trade below fair value in the near term” while the companies face credit risk, uncertain earnings outlook, and the need for additional capital.
He said it is possible the credit metrics could take as long as 2010 to bounce bank. Wachovia and Bank of America could see more cuts in their dividends and also seek more capital later this year.
The Merrill analyst forecasts bank earnings to tumble by an average of 22 percent for 2008 and 19 percent for 2009. The cuts are the result of higher loan losses at banks.
Bank of America and Wachovia could miss second-quarter Wall Street estimates with the largest percentage, Najarian warned.
Bank of America, Regions Financial, SunTrust Banks and Wachovia could see dividend cuts or capital raising or both measures, he said.
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